For decades, Japanese government bonds offered minuscule returns, forcing investors there to look abroad, especially at U.S. financial markets.
Japanese investors now collectively own about $1 trillion in Treasuries and are the largest foreign holders of U.S. debt.
But that could change soon as the Bank of Japan has been hiking rates while hotter inflation has lifted JGB yields, which are now looking more attractive and emerging as an alternative to Treasury bonds.
Yields for 10- and 30-year JGBs have soared to the highest levels since the 1990s, and the central bank is expected to tighten for the fifth time since 2024 as the Iran war sends oil prices higher.
Meanwhile, Prime Minister Sanae Takaichi is seen boosting government spending as part of her efforts to revive growth and offset the oil shock, adding to inflationary trends.
Of course, U.S. yields have also risen as inflation picks up. But the Federal Reserve’s next move is still expected to be a rate cut, though that timeline is getting pushed back further, perhaps into 2027.
There are already signs that money is being repatriated as March saw the largest monthly inflow ever into Japanese sovereign bond funds.
“The new money that’s being put to work won’t be put to work overseas,” Mark Dowding, chief investment officer at BlueBay, told the Financial Times. “It won’t be going into U.S. corporate bonds. It won’t be going into U.S. Treasuries. It will be going into those domestic allocations.”
The asset manager launched its first Japanese bond fund in March, underscoring the sea change that has taken place in the market.
Next month, investors widely anticipate the Bank of Japan to lift rates again, sending the benchmark from a three-decade high of 0.75% to 1%.
That will cap a stunning reversal after the central bank maintained ultra-low rates—and even negative rates for several years—to fight deflation amid a stagnating economy.
Matt Smith, a fund manager at Ruffer, told the FT that he’s betting on the yen appreciating as Japanese investors put more of their money in domestic assets.
“Pressure is building — long-end domestic yields are rising,” he predicted. “And the institutional framework is now ‘please can you bring this money home’. We think yen strength will happen slowly, then quickly.”
But if investors dump U.S. debt en masse, that could force the Treasury to offer even higher yields to attract other buyers.
The market has quickly deteriorated, with a series of debt auctions over the past week drawing muted demand. As a result, the Treasury Department sold $25 billion of 30-year bonds at a 5% yield for the first time since 2007. Before then, no 30-year Treasury carried an interest rate above 4.75%.
It was a stark contrast from mid-February—just before the U.S.-Israeli war on Iran started—when a Treasury offering saw the highest demand ever in the history of 30-year auctions.
Skittishness among bond investors is becoming a trend. In March, auctions for two-, five- and seven-year Treasury notes all saw weak demand, forcing yields to go higher than expected.
At the same time, a flood of corporate bonds is competing with the Treasury for investors’ dollars, putting more upward pressure on yields. And foreign central banks have retreated from the U.S. bond market in recent years, with more price-sensitive hedge funds taking their place as buyers.
Higher yields boost interest costs, which are running at $1 trillion a year, worsening the budget deficit and piling on even more to the total debt burden.
The deficit is already on a troubling path this year. Last week, the Treasury Department announced it expects to borrow more than anticipated this quarter as incoming cash flow has been softer than initially projected.
For Mark Malek, chief investment officer at Siebert Financial, the borrowing update is the latest example of the immense supply of fresh debt that the Treasury Department is issuing.
In a recent blog post titled “The bond market is shouting,” he pointed out that the Fed has cut the benchmark rate by 175 basis points since mid-2024, but the 10-year Treasury yield has only dipped by about 35 basis points while the 30-year yield touched 5%.
“That kind of disconnect is not normal,” Malek warned. “In fact, analysts who have tracked the relationship between Fed policy and long-term yields going back to 1990 describe it as unprecedented. The bond market is not broken. It is sending a message. And if you know how to listen, it is shouting.”
